Mortgage Write-offs
Subprime Mortgage Write-downs and the Mortgage Industry
Headlines continue to splash huge write-downs for many Wall Street banks. What does it all mean and how will it affect the consumer?
Anyone who looks at the Wall Street Journal or any other reputable news source will be confronted by write-offs in the financial sectors. To the layman, write-off is a meaningless word, but it should not be. Over the past year banks have been force to readjust their approach to the mortgage business. Faced with a new playing field, banks have been forced to change the game. Write-offs are a by-product of the new game that everyone in the mortgage industry must now play.
Write-offs Defined
Importantly, write-offs are not cash. When most people see a headline quoting some billion dollar write-off, they assume that the financial institution just lost a large amount of cash. Rather than an actual cash lost, a write-off is a material change in the value of an asset. It’s more easily understood in terms of housing valuations. If a person buys a house at the peak of the market for $500,000, but can now only sell that house for $400,000, they would essentially take a $100,000 write-off of that asset. Write-offs are specific to accounting, so they have no real cash implications. Once an individual sells their house for $400,000, they now have a $100,000 loss. The difference between an actual loss and a write-off is the loss of actual cash versus a change in the value of an asset. This concept is subtle, but extremely important.
Declining Mortgage Values
Banks holding mortgages have to take write-offs because the value of the mortgages they issued have declined significantly. Mortgages decline in value for multiple reasons: change in interest rates, change in creditworthiness of borrowers, etc. Most recently, mortgage values have been declining because of the increased concern of the consumer’s welfare. Under normal market conditions, mortgage values would have declined amid an expected recession. However, when combined with the tremendously lax underwriting standards of the past four years, the situation proves to be extremely volatile. This combination has lead to a huge drop in values of subprime mortgages, Alt-A mortgage, and Jumbo mortgages.
Permanent Changes in the Mortgage Industry
Physics proves every action has an equal and opposite reaction. In this case, the free money days of the early 2000s will have a dramatic overcorrection in the tail end of the decade, possibly even spilling over into the next. Like all cycles, this too shall pass. The best advice for anyone seeking a mortgage or considering moving is to simply wait out the storm. Right now prices still have a ways to drop and mortgage rates are very unpredictable.
